Fraudulent Disbursements: Understanding and Preventing Unauthorized Payments

4.4 Fraudulent Disbursements

Fraudulent disbursements represent one of the most prevalent forms of occupational fraud, where perpetrators make unauthorized payments from an organization’s funds. Understanding these schemes is crucial for forensic accountants and auditors, as they often involve complex manipulations of financial records. This section delves into the various types of fraudulent disbursements, including billing schemes and payroll fraud, and provides insights into detection and prevention strategies.

Understanding Fraudulent Disbursements

Fraudulent disbursements occur when an employee or an external party manipulates the disbursement process to divert company funds for personal gain. These schemes can take many forms, including:

• Billing Schemes: Involving the submission of false invoices or inflated bills.
• Payroll Fraud: Entailing the manipulation of payroll systems to issue unauthorized payments.
• Expense Reimbursement Schemes: Involving the submission of fictitious or inflated expense reports.
• Check Tampering: Altering or forging checks to redirect funds.
• Wire Transfer Fraud: Unauthorized electronic transfers of funds.

Billing Schemes

Billing schemes are among the most common types of fraudulent disbursements. They involve the creation of false documentation to generate payments for fictitious goods or services. Key types include:

Shell Company Schemes

A shell company scheme involves setting up a fictitious entity to bill the victim organization for non-existent goods or services. The fraudster creates invoices from the shell company and processes them through the accounts payable system.

Example: An employee sets up a shell company and submits invoices for consulting services that were never rendered. Payments are made to the shell company, and the funds are then siphoned off by the fraudster.

Non-Accomplice Vendor Schemes

In this scheme, the fraudster uses the identity of a legitimate vendor without their knowledge. They may alter the vendor’s invoice to inflate amounts or create entirely fictitious invoices.

Example: An accounts payable clerk intercepts vendor invoices, alters the payment amount, and diverts the excess funds to their own account.

Personal Purchases with Company Funds

This involves using company funds to pay for personal expenses. The fraudster submits invoices for personal purchases disguised as business expenses.

Example: An employee uses a company credit card to purchase personal items and submits the receipts as business expenses.

Payroll Fraud

Payroll fraud is another significant category of fraudulent disbursements, where the payroll system is manipulated to issue unauthorized payments. Common methods include:

Ghost Employees

Ghost employee schemes involve creating fictitious employees in the payroll system. The fraudster collects the salary payments issued to these non-existent employees.

Example: A payroll manager adds a ghost employee to the payroll system and directs the payments to their own bank account.

Falsified Hours and Salary

This scheme involves inflating the number of hours worked or increasing the salary rate for unauthorized payments.

Example: An employee collaborates with a payroll clerk to record additional hours worked, resulting in inflated paychecks.

Commission Schemes

Commission schemes involve manipulating sales records to increase commission payouts.

Example: A salesperson fabricates sales records to boost their commission earnings.

Detection and Prevention Strategies

Detecting and preventing fraudulent disbursements requires a multi-faceted approach, combining internal controls, data analytics, and employee awareness. Here are some effective strategies:

Internal Controls

Implementing robust internal controls is essential to prevent fraudulent disbursements. Key controls include:

• Segregation of Duties: Ensure that no single employee has control over all aspects of a financial transaction. For example, separate the responsibilities of invoice approval and payment processing.
• Authorization and Approval: Require management approval for all disbursements above a certain threshold.
• Vendor Verification: Regularly verify the legitimacy of vendors and conduct background checks on new vendors.

Data Analytics

Utilizing data analytics can help identify anomalies indicative of fraudulent disbursements. Techniques include:

• Benford’s Law: Analyze the frequency distribution of leading digits in financial data to detect irregularities.
• Trend Analysis: Monitor trends in disbursements to identify unusual patterns or spikes.
• Exception Reporting: Generate reports highlighting transactions that deviate from established norms.

Employee Awareness and Training

Educating employees about the risks and signs of fraudulent disbursements is crucial. Training programs should cover:

• Fraud Awareness: Teach employees how to recognize red flags and report suspicious activities.
• Ethical Conduct: Promote a culture of integrity and ethical behavior within the organization.

Case Studies and Real-World Examples

Examining real-world cases can provide valuable insights into the mechanics of fraudulent disbursements and the effectiveness of detection and prevention strategies.

Case Study: The City of Dixon Fraud

In one of the largest municipal fraud cases in U.S. history, the City of Dixon, Illinois, lost over $53 million due to fraudulent disbursements orchestrated by the city comptroller. The fraudster created fictitious invoices and diverted funds into a secret bank account over two decades. This case highlights the importance of segregation of duties and regular audits.

Case Study: Payroll Fraud at a Manufacturing Company

A manufacturing company discovered payroll fraud when an internal audit revealed discrepancies in employee records. The payroll manager had added ghost employees and manipulated timesheets to issue unauthorized payments. The company implemented stricter controls and enhanced oversight to prevent future occurrences.

Regulatory and Compliance Considerations

In Canada, organizations must adhere to various accounting standards and regulations to prevent and detect fraudulent disbursements. Key regulatory frameworks include:

• International Financial Reporting Standards (IFRS): As adopted in Canada, IFRS provides guidelines for financial reporting and disclosure, ensuring transparency and accountability.
• Canadian Securities Administrators (CSA): The CSA oversees securities regulation and enforces compliance with anti-fraud measures.
• CPA Canada: Provides resources and guidance on best practices for fraud prevention and detection.

Best Practices for Forensic Accountants

Forensic accountants play a vital role in investigating fraudulent disbursements. Best practices include:

• Conducting Thorough Investigations: Use a systematic approach to gather evidence, analyze financial records, and interview relevant parties.
• Collaborating with Legal and Regulatory Authorities: Work closely with law enforcement and regulatory bodies to ensure compliance and facilitate prosecution.
• Staying Informed: Keep abreast of emerging fraud trends and technological advancements to enhance detection and prevention efforts.

Conclusion

Fraudulent disbursements pose a significant threat to organizations, but with the right strategies and controls, they can be effectively managed. By understanding the various schemes, implementing robust internal controls, and fostering a culture of integrity, organizations can protect themselves from financial losses and reputational damage. Forensic accountants and auditors must remain vigilant and proactive in their efforts to detect and prevent fraudulent disbursements.

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